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By Robert Rapier on Mar 20, 2012 with 19 responses

Are You Looking to Invest in the Google of Biofuels?

The Big Names in Biofuels

So you’re hoping to strike it rich by investing in LanzaTech. Or Solazyme. Or KiOR. Or Gevo. After all, some of these companies recently had high-profile IPOs, and they are clearly “hot” given all of the press coverage devoted to them. So perhaps you have decided you want to get in on a potentially unique investment opportunity.

I get more e-mails and phone calls about investments than on any other topic. And it’s not just individual investors. I hear from institutional and private equity investors trying to determine what’s true and what’s hype, and asking whether KiOR or LanzaTech might turn out to be the Google (GOOG) or Apple (AAPL) of biofuels. Before offering any guidance, the first thing I try to do is establish your reason for investing. Are you looking for — in the words of former Fidelity Magellan’s Peter Lynch — a “ten bagger?” Are you looking for a hedge against the end of the oil age? Is this money that you are fully prepared to lose?

The second thing I would ask you is whether you really understand the company, their business model, their competition, and their potential technical challenges. (This is typically why people e-mail me — because they have questions about these things). Let me offer an example from my own investing history to demonstrate why these issues are important by telling you about the worst investing mistake I ever made.

Jumping Into Tech Stocks in the Late 90′s

Prior to 1999, what little investing I did directly with stocks tended toward blue chip stocks, or companies that were familiar to me. The risks weren’t exceptional, but neither were the rewards. Around 1999, technology stocks began to climb, and I kept hearing the “experts” talk about how the sky was the limit for companies like Cisco (CSCO) and JDS Uniphase (JDSU).  I was reading stories in Money Magazine about housewives who were becoming millionaires by investing in America Online. All of the media attention made me feel like I was missing a big opportunity. I knew that the Internet was going to be huge. After all, I used the Internet frequently before the World Wide Web was invented, and once Netscape became available and made browsing the Internet much easier, the growth potential was clear. After reading one more column by Jim Jubak that convinced me that JDSU would soon be worth more than France, I finally had enough. So I bought some shares in JDSU (among others), watched them double, bought some more on margin, watched them double again, then sold a few at some point and actually made some money. Then the bottom fell out. The graphic below tells the tale.

If you had asked me about JDSU’s core business, I could have recited the description on their website. But who were their competitors? What were the threats to their business? I didn’t really know, but the talking heads on CNBC and MSN Money had convinced me that it was a no-brainer. Over time it became very clear to me that I was simply gambling, not investing. I was taking the advice of people who in many cases didn’t understand these businesses themselves, but who had an impressive track record primarily because they had been making their recommendations in the face of a rising market. When the stock price in JDSU started to fall, I was uncertain whether to sell, because I didn’t really understand the long-term prospects.

There are of course numerous tech stocks whose stock charts look like that of JDSU. And there were numerous people who rode them all the way down — convinced that a correction was just around the corner. Many people — myself included — now look at those charts in hindsight and wonder how we could have been so stupid. Ten years from now many people will look at charts of certain biofuel companies like the following one and wonder how they could have been so stupid:

Understand Where You’re Putting Your Money

I learned some hard lessons over my foray into tech stocks, but the most important one was never again to invest in something I don’t understand. It was simply too hard to sort out the pretenders from the contenders. In the case of JDSU, the company actually turned out to be a good company, and is still in business today. It just wasn’t worth what many of the analysts were suggesting, and as a result a lot of people lost money. In plenty of other cases, though, a technology company simply had a poor business model and investors bought into the hype.

In 2006, investing in the ethanol business might have appeared to be as much a no-brainer as investing in the Internet appeared to be in 1999. The Renewable Fuel Standard had been passed, mandating that growing volumes of ethanol had to be blended into the U.S. fuel supply. Refiners were phasing out the oxygenate MTBE and replacing it with ethanol. This was definitely a prescription for growth, and publicly traded ethanol companies like Pacific Ethanol (PEIX) started to ride the wave. When Bill Gates (or to be perfectly accurate, Cascade Investment, his investment vehicle) bought 25% of Pacific Ethanol in 2006, many viewed that as a sign that the smart money was moving in.

But in June 2006 — not long after Bill Gates bought in — I wrote an article when Pacific Ethanol was still trading in the $20′s in which I warned that “the underlying fundamentals (specifically of Pacific Ethanol) make it a very risky investment”, “ethanol companies are in the same boat (as dot-coms before their crash)”, and “I don’t think the underlying fundamentals warrant the valuations placed on grain ethanol producers.” (For all of the links related to the original story and follow-ups, see Investing in Ethanol: A Case Study of Terrible Investment Advice). I wrote that article in response to an article advising people that investing in ethanol companies was a no-brainer.

You can see from the stock chart of Pacific Ethanol what happened. It didn’t take place as quickly as with the tech stock bubble, but just like JDSU, Pacific Ethanol’s value declined by more than 90%. Cascade Investment finally saw the handwriting on the wall in 2008, and began to sell off their shares at under $4 a share.

What went wrong? Cascade Investment made the same mistake with this investment that I made with my tech stock investments: They invested Bill Gates’ money in something that seemed like a no-brainer, but which they did not fully understand. They did not know the real, underlying value of PEIX and their business model. Bill Gates knows enough about the computer industry that he might have had better sense than to invest into the dot-com bubble. But I knew enough about the biofuels industry to ignore all of the “Strong Buy” recommendations that popped up in the wake of Bill Gates’ investment, so I wrote the article urging caution.

Of course the ethanol industry itself continued to grow, just as the Internet continued to grow after the dot-com bubble burst. Companies like POET (which is, incidentally, privately held) have enjoyed phenomenal growth rates. But for every POET out there — a company that has solid management, knows its business well, and did not overextend itself — there are numerous companies that are filling investor’s heads with false promises. These are the companies whose stock charts will eventually look something like that of Pacific Ethanol’s.

In fact, of the existing advanced biofuel companies today, I predict that more than 90% will eventually go under. The reasons will vary, but mostly boil down to the economics of competing against even $100/bbl oil. Corn ethanol can do it as long as natural gas and corn prices are low. But not too many of the advanced biofuels can, and this is where these companies will eventually run into trouble. In some cases they will drag it out for years, but the end for most will look like the end of Range Fuels: Hyped expectations will meet reality, and investors will move on to more promising prospects.

How to Ask the Right Questions

But what if you are still interested in investing in biofuels, and just want to know how to minimize your risks? I wrote an article with that in mind called Due Diligence: How to Evaluate a Renewable Energy Technology. I expand upon this topic in my upcoming book Power Plays (scheduled to be released next week) and discuss many of the advanced biofuel options.

The short answer is that knowing which questions to ask will greatly lower your risks. Of the biofuel companies out there today, I don’t think we will see a Google or an Apple. The fuel business has always been a capital intensive, low margin business. If one could invest for the long-term in a company like POET, you would not likely see long-term explosive growth, but rather the modest growth rates that one sees in a utility or energy company.

So make sure your expectations are realistic, you understand the basic business of the company, and that you ask the right questions. Then you can make an intelligent decision on whether KiOR or Solazyme belongs in your portfolio.

Link to Original Article: Are You Looking to Invest in the Google of Biofuels?

By Robert Rapier

Footnote: I am traveling to San Francisco on business on March 21st, returning March 24th. I won’t post a video blog this week, and my answers to e-mails and comments will be delayed.

  1. By Edward Kerr on March 20, 2012 at 9:22 am

    Robert,

    Interesting and informative post. It does beg a few questions. Point: we (humanity) will continue to need liquid fuels long after fossil reserves have fallen to the point of being all but useless. Corn ethanol, as you note, has several drawbacks and is skating on thin ice when considering “personal financial investment’. It (corn ethanol) has already demonstrated that the potential for it to be a long term solution just isn’t in the cards.

    Since, as you also note, fuels in general are “low margin” commodities is it realistic to assume that the private sector can solve the major looming  problem of  “peak oil” (though I think that we have passed that point, at least in regard to easily recoverable oil)  Of course, the track record of government involvement, no matter how well meaning, has been less than stellar. So what then is your answer to what we should be looking to in an effort to continue enjoying the “fruits” (almost tongue in cheek) of fossil oil?

    With bated breath….

    Edward Kerr

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  2. By BBM on March 20, 2012 at 11:54 am

    Oh yeah.  I bought JDSU also.  Brings back memories.  Good times.

    I always appreciate your cautionary realistic approach to this blog.  Thanks for keeping it up.

     

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  3. By John on March 20, 2012 at 7:07 pm

    The only surefire way to make money in biofuels is to short anything Khosla has touched before the insider lockups expire. KiOR, for example, bought me a rather nice sailboat. Thanks, Vinod!

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  4. By fred on March 21, 2012 at 12:39 am

    lanzatech is not a public company

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    • By Robert Rapier on March 21, 2012 at 2:25 am

      lanzatech is not a public company

      I know that. But they have taken on a lot of private investment, and the same principles apply.

      RR

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  5. By Benny BND Cole on March 21, 2012 at 12:57 pm

    As usual, excellent commentary by RR. BTW if RR ever wants to open up a consulting company with me….we can make lots of money. 

    OT, but interesting:  I have been married to a Thai for the last 10 years, and so visit that nation often. On each visit, the use of CNG and recently especially LPG has become more pronounced. There are huge LPG stations. 

    Why LPG? I don’t know, but if RR wants to tackle….

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  6. By BilB on March 21, 2012 at 3:42 pm

    A lot of good advice in the above.

    I would add that there will be reliable money to be made from biofuels, but at the right time. A right time would be to buy when an industry was about to make a major efficiency transition. For instance if corn ethanol distillers were transitioning from burning gas powering of their plants to burning the stover field byproduct biofuel, and solid evaluation proved a major cost saving, then that might well be an opportunity time.

    Another might be before US gasoline makes the jump to $6 per gallon and will be sustained at that level. That could very well happen in the 6 years with population increase and Asian energy demand.

    The qualifier is that the broadest based earnings to be made from energy are at the individual level. There are sufficient technologies available to make it possible for large sections of the global community to become energy independent. There will be an energy cost trigger point to make many of these technologies viable and desireable and much of that will happen as oil prices rise with declining oil availability.

    I expect that the most money to be made will be in energy and energy technology distribution, rather than energy production. And in this the opportunity will be a long term prospect rather than a flash profit opportunity. Having said that there will be a number of ”energy iPod” ‘s amoungst the array of technologies. Spotting them will require real technological understanding and, as Robert says, proper evaluation.

    My hot tip is to watch NASA’s Omega energy project. I do know exactly where this technology is in its development path, and I believe that it has the best long term prospects. The tip is that the easy profit opportunities with this technology will not be the most obvious ones.

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  7. By BilB on March 21, 2012 at 8:18 pm

    Just looking at it now, the KiOR concept looks quite intriguing. I am going to research the process to see where the fishhooks are, and how scalable (both ways) the process is.

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  8. By ben on March 21, 2012 at 10:34 pm

    At the risk of tossing a wet blanket, there will NOT be a Google of biofuels.  Nothing against this market segment, but the field doesn’t really lend itself to a “ten bagger” particularly compared to IT, software, etc..   I’m not sure there are too many “five baggers” out here, either.  That doesn’t mean there isn’t some profitability in biofuels for savvy investors.  It simply suggests that competitive advantage in this sector is narrow, points of entry are rather numerous and attendant capital requirements/project development timelines have a way of slowing the pace for the competitors.  Short of government intervention in erecting anti-competitive barriers to entry (guess we’ve seen some of that in the past, eh) the marketplace offers ample points of participation and plenty of tech-IP  applications to accommodate a broad range of producers in each market segment.   Capitalization and capital recovery remain time-consuming propositions.

    As RR rightly points out, short of the razzle-dazzle IPO two-step by way of Metro SF/Manhattan, the prospects of a securing a slam dunk in biofuels is probably as likely as getting ADM/Cargill to admit in a Congressional hearing that corn growers as family farmers was a late 2oth century version of an economic Potemkin Village; an invention to assist a couple of industry giants smooth a troublesome seasonal supply/demand challenge in the fructose market.   Now, that would be quite a confession.  But let’s not hold our breath:)          

     Ben     

        

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  9. By RA on March 22, 2012 at 5:18 pm

    So at this point Pacific Ethanol looks like a 100% gamble? Or there is some potential in this stock?

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  10. By BilB on March 22, 2012 at 6:37 pm

    RA,

    That is the wrong question. Robert’s point is entirely that you have to look at the company’s prospects yourself. In general when looking at biofuels you have to understand that this is a ….distributed….. industry. Everyone can do it, and they can do it everywhere. And this is simply because the suns energy is distributed as is the territory upon which to collect the energy. So biofuels will never offer the concentrated profits that can be achieved from oil. That is not to say, though, that there are not real value opportunities from the renewables sector, because there are. You have to realise that these opportunbities will not look the same as they do for traditional energy sectors. You are going to have to think about it, do research and identify the opportunities for yourself.

    But here is a clue to put you in the right direction. The Howard Hughes family fortune came not from oil but from the drill bits that made the drilling possible.

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    • By Joanne Ivancic on March 23, 2012 at 7:53 pm

      Could be that technologies that lead to cheap sugars (not sucrose, but those from cellulose, hemicellulose, pectin from ag residues, paper pulp, etc.) are the analogy to the drill bit.

      For more examples of some questions to ask when investing in this space and other reference materials, see http://advancedbiofuelsusa.info/biofuels-basics/about-advanced-biofuels

      Not many businesses in this space that need financing are publicly funded.  If you are really looking for a thrill, take a look close at those.

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  11. By RogiAnorov on March 22, 2012 at 9:14 pm

    I think you are right. Only the problem – people are looking for non-brainier. I am afraid I am one of them…

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  12. By BilB on March 23, 2012 at 1:24 am

    OK Rogianorov. You’re seeking to get rich quick without any effort. So am I.

    No Problem. Give me your money and I will invest it for you!!

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  13. By Alex on March 23, 2012 at 6:41 am

    Extremely interesting article on biofuels.

    I’m a former oil refiner but spent time in the renewable sector and while the recommendation of looking at the segment and company with competent eyes remains extremely valid, I found it extremely difficult to value the future valuation of a company like KiOR …  

    It is clear that pyrolysis is a good way to get syngas and that the fluid catalytic cracking may increase the yield of gasoline/diesel “like” components but all these processes have some clear qualifiers that do not appear to be in the public domain:
    1- the composition of  the gasoline and blending feedstock derived by the process are not known: depending on the level of undesirable components the stability/viscosity/oxygen content can heavily impact on the max % that can be blended in the final product pool, impacting on its attractiveness for a traditional refiner … and therefore price

    2- CAPEX and OPEX per gallon of diesel/gasoline production …while CAPEX may be derived from available info and adjusted for scaled up projects there is little said about OPEX… what happened to the 70-75% weigh of the feedstock that does not end in the product stream. How much of this is used to generate heat and power and how much of this   is waste to be disposed ..and at what environmental + $ cost?

    3- Business model: Kior wanted originally to make money through licences. This is a classic route.You typically would get paid for the Process Design Package, then enter into an agreement to supply proprietary catalyst (exclusively) for the life of the project and on top of it you get a royalty for each gallon produced. You may also sell some of the propriatary equipment to mak some more buck and preserve your technology. Kior then shifted the model and chose the  fully owned greenfield facility route. Clever move … nobody will commit in spending $300M for a plant without a reference…

    Now the real value of the company in my opinion is in the original path: the licensing. The current plant is a key enabler but it is clear than 10 years down the road there will be 2 or 3 tech max competing globally on this same process … the real question is to understand if Kior will be one these 2 max 3 companies …

    If the answer is yes then KiOR will be round the globe licensing new plants, getting royalty and having a process and start up team to support EPCs and operators. In parallel KiOR may use it’s own facility to improve the process/catalyst and with the right financial backing continue investing in new plants, with a separate team. As an example Shell Global Solution, Chevron, Exxon etc do have propriatary processes that they license to others, not only to cash royalties but also to increase their market coverage in terms of high tech players and get technical feedback to improve their processes in the first place

    If the answer is no, then on one side no high margin royalties will be cashed in but also their own plant and product will be less competitive that the ones using the successful process (es)… and therefore their margin on product sales will be lower than the competition … and the feedstock suppliers will be keen in serving the richest competitors … a nightmare

    There is no in between situation unfortunately.

    I have looked at this segment for a couple of hours only, if anybody has from the public domain a comparison of the current technologies in the Biomass-to-fuel segment I’d be happy to review and eventually come back to you with my humble thoughts

     

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  14. By ben on March 23, 2012 at 12:07 pm

    Alex

    Alex–Thanks for the very relevant/succinct overview of KiOR–a past point of exchange with RR/others.   Their model was always purposefully vague w. OPEX (esp. process energy) as the rub.  IPO was further testimony to the “sizzle peddling” from early investors looking toward a soft (profitable) landing; a built-in policy challenge in how the self-appointed “winners” secure funding.  This is particulary true as it bears on how a large measure of capital risk gets foisted onto the taxpayers via Washington’s amateur (politicized) due diligence; something that I witness routinely in dealing with multilateral trade-funding institutions.   

    It would be good to keep this line of thought simmering in this space or off-line.  Biomass-to-fuels comparisons invokes a very broad waterfront.

    Ben

     

     

     

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  15. By mac on April 23, 2012 at 7:23 pm

    Yeah, I lost money on my Intel Stock that tanked at 12 bucks a share, but now it’s worth $27 a share.

    Tell me about it.

     

    Patience,  my friend…….

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  16. By mac on April 23, 2012 at 7:30 pm

    Yup , I hung on to INTEL.

    Good Company

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  17. By mac on April 23, 2012 at 7:48 pm

    If  you want to make money in the stock market, you cannot panic when speculators temporarily drive up or down the price of  stocks.

    Mac

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